Unisys (NYSE: [[UIS]]) presents a compelling investment
opportunity for patient value investors that could double based on
current prospects or triple from current levels if management
allocates capital wisely. Investment highlights follow:
At its current share price of ~$20 and market cap of $870M, UIS
is trading at less than 3 times its pretax profits. This is
ridiculously cheap, especially when considering its
cash position of $367M.
Under CEO Ed Coleman's 3-year turnaround program, Unisys has
dramatically improved its operations, and achieved its goal of
$350M in annual pretax profits.
Strong Balance Sheet:
Impressively, Unisys has paid down $1 billion in debt since 2008
and now boasts a strong cash position of $659M against debt of
: Unisys has over $2 billion in potential net operating loss
(NOL) carry forwards to offset future taxation. These deferred
tax assets will become more valuable as its operating profits
continue to improve. Also, as today's super-low interest rates
normalize to higher levels, the overhang of Unisys' pension
obligations will diminish. In effect, Unisys stock has an
embedded hedge against rising interest rates.
As Unisys continues to demonstrate its pretax earnings power of
$7 per share is sustainable and that its pension obligations are
manageable, the shares should rise to $35. Legislative relief on
pension funding requirements will help too. If the company uses
its cash hoard to buy back its super cheap shares, Unisys could
even triple to $60. Given CEO Ed Coleman's history of selling
Compucom and Gateway, we would not be surprised to see a sale of
Unisys to an IT firm or private equity.
Unisys is an information technology pioneer with roots dating
back 139 years. The company's predecessors, Burroughs and Sperry,
were stalwarts of the mainframe era that merged in 1986 to form
Unisys. Soon afterwards, however, the mainframe computer industry
began a long-term decline. In response, Unisys began a shift toward
high-end servers (such as Windows NT) and IT services. However,
supporting and upgrading the company's mainframe platform, known as
ClearPath, has remained a lucrative business. By the mid-1990s,
services and solutions became the company's largest business. This
would eventually form the core of Unisys' IT outsourcing and
systems integration businesses.
The period from 2000-2008 was a troubled period for Unisys. As
its technology business shrank and even its services business
stagnated, the company reported massive losses, which were further
aggravated by the recession. In mid-2008, an activist investment
firm named MMI Investments with over 9% of Unisys' shares was able
to get two positions on the company's board of directors to clamor
for changes, including the divestment of its government business.
The CEO, Joe McGrath, was ousted in September 2008, and a new CEO,
Ed Coleman, came to the helm.
Coleman brought an impressive turnaround track record in the
technology industry. Most recently as CEO of Gateway, he prepped
that struggling PC maker for sale at a nice premium to Taiwan-based
Acer. Before that, as CEO of the leading IT reseller Compucom, he
oversaw that company's transformation from a product pusher to a
services provider and then sold the company to a private equity
firm. (As management consultants in the high tech industry, the
writers of this article became familiar with Compucom's operations
and its successful transformation).
Coleman's tenure at Unisys began in October 2008 as the global
economy was cratering, The market had left the company for dead,
knocking the company's market cap down hard. The company announced
cost reductions of over $200 million to staunch the cash burn, and
indicated that it would concentrate its investments and resources
in fewer, more profitable IT segments (later articulated as
security, data center transformation, end user outsourcing, and
By mid-2009 signs emerged that the company's efforts had averted
catastrophe and Unisys returned to slight profitability even as
sales plunged. Amid the credit crisis, the company was forced to
refinance its debts at loan-shark rates. The company also began a
divestment program to raise cash and pay down debt, including the
sale of its Medicare IT business to raise cash.
In late 2010, the company formulated a business turnaround plan
with the following goals:
- Pre-tax Profit: Increase annual pre-tax profit to $350M in
2013, excluding any change in pension income/expense from 2010
- Operational Efficiency: Consistently deliver 8-10% services
- Revenue Growth
- Grow IT outsourcing and system integration at market
- Maintain stable Technology revenue
- Debt Reduction: By year end 2013, reduce outstanding debt by
These were bold goals - to simultaneously improve profits and
revenue, even while drastically de-leveraging the balance sheet.
Not to mention a period of economic uncertainty and public sector
austerity. But fast forward to today (mid-2012), and the company
has achieved all of these goals ahead of time. The execution has
In spite of the remarkable success of this turnaround, the
market gives Unisys stock little respect. As mentioned above, the
shares trade at merely 3 times the company's pretax profits. What
is holding it back?
Well, macro conditions are playing a part. About 40% of Unisys
revenue comes from public sector customers. As governments in
Europe undertake austerity measures and the US federal government
stand-off points the country toward a "fiscal cliff, there will no
doubt be some turmoil. But at the end of the day, Unisys contracts
are in non-discretionary areas. The company has achieved its
turnaround goals in spite of winding down some big contracts such
as the 2002 TSA deal which rolled off in 2010. Investor fear in
this area seems overdone and should eventually subside.
Also, the market is unfairly viewing Unisys as a stodgy relic
from a bygone era. Admittedly, the company's flagship ClearPath
mainframe platform is still a significant factor in its business.
But Unisys has done a nice job of porting ClearPath to modern
server technologies such as Java. The company expects ClearPath
revenues to be stable (though lumpy quarter to quarter) over time.
Today, more than 90% of Unisys revenues comes from other sources,
such as IT outsourcing, systems integration and business process
outsourcing which are growing at a nice clip. Unisys is also
creating strong capabilities in crucial new areas such as security
and data center.
A more substantive overhang over Unisys shares is its legacy
pension liability. While Unisys froze its pension plan years ago,
it is still on the hook for vested beneficiaries and retirees. At
the end of 2011, Unisys indicated its pension plans were
underfunded by nearly $2 billion. At first glance this sounds
really scary for a company with a current market cap of only $870
million. But as recently as 2008, Unisys' pensions were fully
To understand this, it is crucial to understand that the
projected payouts to retirees have not actually changed. Instead,
the discount rate at which the series of pension payouts is made
has plunged as central banks in the US and Europe have embarked
upon zero interest rate and quantitative easing policies which
artificially suppress long term bond interest rates. The US 10-year
Treasury yield is 1.5%. Pension regulations demand that pension
liability calculations use these long term bond interest rates as
factors for their pension liability discount rates.
This accounting artifact has caused the "present value" of the
pension payouts to explode over the past two years, even though the
payouts themselves have not changed. (For this reason, we believe
that Unisys stock is an excellent way to hedge against rising
interest rates - it contains an embedded "short" of long-term
bonds. Once interest rates normalize, the pension overhang
vaporizes.) Management has stated for every 25 basis rise in their
discount rates, ~$125 million of the pension overhang goes away. A
1.50% rise in rates eliminates a phantom liability equal to the
current Unisys market capitalization.
Of course, this effect cuts both ways. If interest rates
actually decline further from their already microscopic levels,
this phantom pension liability could increase due to the discount
rate effect. While this would not fundamentally impair Unisys'
intrinsic value, some may perceive this as a risk as rates could be
volatile in the near term. However, value investors who believe, as
we do, that long term interest rates will eventually rise, ought to
ignore short term volatility (or better yet, exploit it).
Given the pension overhang, how much is Unisys stock actually
worth? Let's get back to basics and build a discounted cash flow
model. As the baseline, let's make the following assumptions:
(i) profit before taxes and pension contributions of $350
million (they currently exceed this on a TTM basis) is sustained,
but does not grow
(ii) pension contributions conform to the company's expected
schedule under the current legislative environment, but we will
conservatively assume there is a leftover annual payment of $170
)) tax rate of 30% (this is conservative given the largely untapped
The resulting valuation of $35 per share is quite conservative.
If long term interest rates increase, or Unisys refinances its debt
at lower interest rates, or Unisys is able to better capture the
value of its deferred tax assets, the value is much higher. If
management pivots from a mode of fear-driven debt reductions and
captures the potential value created through accretive share
repurchases, the intrinsic value could exceed $60 per share.
While we believe that value is its own catalyst, it is key to
note that there are significant events that could re-price the
stock up toward its intrinsic value:
What takes Unisys to $35
- The US budget stand-off and European austerity don't cause
the end of the world
- Unisys continues to demonstrate sustainability of its
operations and earnings power
- Unisys management does a better job communicating to
investors about how undervalued its stock price is
What takes Unisys to $60+
- Management undertakes share buybacks at attractive prices
(below $30 per share)
- Long term interest rates eventually normalize to historical
- Unisys profit levels actually rise
- Unisys unlocks value of its deferred tax assets (NOLs) as US
business profits grow
- Unisys attracts a buyout offer from a strategic buyer or
private equity fund
KMF Investments may hold a position in the securities mentioned
in this article.
I am long [[UIS]].
Silver Wheaton Corporation: The $100.00 Silver